Summary of the course international corporate finance based on the courses and slides thought by Prof. dr. James Thewissen. With this sumary I eventually got the grade 20/20.
INTERNATIONAL
CORPORATE
FINANCE
Prof. dr. James Thewissen
Pauline Delphine Verhelst
VUB | 2021-2022
,INHOUDSOPGAVE
PART 0 - INTRODUCTION AND MOTIVATION ................................................................................... 5
1. INTERNATIONAL FINANCE OR THE EXISTENCE OF BORDERS ...................................................................... 5
2. BORDERS COMPLICATE THE JOB OF THE CFO ....................................................................................... 6
2.1. EXCHANGE RATE RISK ......................................................................................................................... 6
2.2. SEGMENTATION OF CONSUMER-GOODS MARKETS – THE BIG MAC STANDARD .............................................. 7
2.3. CREDIT RISK ...................................................................................................................................... 7
2.4. POLITICAL RISK .................................................................................................................................. 7
2.5. INTERNATIONAL TAX ISSUES ................................................................................................................. 7
3. WHY IS INTERNATIONAL FINANCE USEFUL? ......................................................................................... 7
4. MONEY AND BANKING A BRIEF HISTORY ............................................................................................. 7
4.1. USE OF MONEY ................................................................................................................................. 8
4.2. AT THE BEGINNING ............................................................................................................................ 8
4.3. RECENT HISTORY ............................................................................................................................... 9
4.4. TODAY........................................................................................................................................... 11
5. AN IDEAL CURRENCY .................................................................................................................... 12
6. EXCHANGE RATE REGIMES............................................................................................................. 13
7. THE EURO ................................................................................................................................. 15
PART I - ARCHITECTURE OF INTERNATIONAL MARKETS ................................................................. 17
1. SPOT MARKETS FOR FOREIGN CURRENCY .......................................................................................... 17
1.1. MAJOR MARKETS ............................................................................................................................ 17
1.1.1. Market Segments ..................................................................................................................... 17
1.1.2. Geography and market size ..................................................................................................... 18
1.1.3. Transaction types ..................................................................................................................... 19
1.2. EXCHANGE RATES ............................................................................................................................ 20
1.2.1. Our convention: HC units per unit of FC .................................................................................. 20
1.2.2. Bid and ask spread ................................................................................................................... 21
1.2.3. Primary and cross rates ........................................................................................................... 21
1.3. THE LAW OF ONE PRICE FOR THE STOCK MARKET ................................................................................... 23
1.3.1. Two-way arbitrage ................................................................................................................... 23
1.3.2. Triangular arbitrage ................................................................................................................. 26
1.4. FORWARD CONTRACTS ..................................................................................................................... 30
1.4.1. Definition ................................................................................................................................. 30
1.4.2. Relevance of forward contracts ............................................................................................... 31
2. CONTEMPORARY ISSUES IN FINANCE INTERNATIONAL FINANCE: DO WE KNOW WHAT MAKES FOREX MARKETS
TICK? .............................................................................................................................................. 32
2.1. STATISTICS ..................................................................................................................................... 33
2.2. BEHAVIOR OF SPOT EXCHANGE RATES.................................................................................................. 35
2.2.1. Changes in logs of levels: Findings ........................................................................................... 36
2.3. EXCHANGE RATES AND ECONOMIC POLICY FUNDAMENTALS.................................................................... 38
2.3.1. The monetary model ............................................................................................................... 38
2.3.2. Results...................................................................................................................................... 39
2.3.3. Discussion ................................................................................................................................ 40
3. ASIAN CURRENCY CRISIS .............................................................................................................. 42
1
,PART II – INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION .............. 47
1. PURCHASING POWER AND INTEREST RATE PARITIES ........................................................................... 47
1.1. THE PURCHASING POWER PARITY........................................................................................................ 47
1.1.1. Absolute PPP ............................................................................................................................ 47
1.1.2. Relative purchasing power parity ............................................................................................ 51
1.2. THE COVERED INTEREST RATE PARTY ................................................................................................... 54
1.2.1. Perfect market assumption...................................................................................................... 55
1.2.2. General formula ....................................................................................................................... 60
1.2.3. In practice - the carry trade ..................................................................................................... 63
2. PARITY CONDITIONS - EXERCISES .................................................................................................... 64
2.1. ABSOLUTE PURCHASING POWER PARITY.............................................................................................. 64
2.2. ABSOLUTE PURCHASING POWER PARITY.............................................................................................. 64
2.3. RELATIVE PP................................................................................................................................... 65
2.4. REAL APPRECIATIONS/DEPRECIATIONS ................................................................................................. 65
2.5. CARRY TRADE.................................................................................................................................. 65
2.6. UNCOVERED INTEREST RATE PARITY.................................................................................................... 66
3. TRANSACTION EXPOSURE: MANAGING CONTRACTUAL EXCHANGE RATE EXPOSURE .................................... 67
3.1. WHY DO YOU NEED TO UNDERSTAND FX EXPOSURE? ............................................................................. 67
3.2. INTRODUCTION TO TRANSACTION EXPOSURE ........................................................................................ 68
3.2.1. Forward contract ..................................................................................................................... 70
3.2.2. Hedging with options ............................................................................................................... 73
3.2.3. Examples - comparing the three hedges ................................................................................. 74
4. TRANSACTION EXPOSURE – EXERCISES ............................................................................................. 76
4.1. ITALIAN ACCOUNT RECEIVABLE .......................................................................................................... 76
4.2. JAPANESE ACCOUNT PAYABLE............................................................................................................ 77
4.3. BRITISH TELECOM BIDDING ................................................................................................................ 78
PART IV – INTERNATIONAL CAPITAL MARKETS .............................................................................. 80
1. SEGMENTATION AND INTEGRATION IN THE WORLD'S STOCK EXCHANGE................................................... 80
1.1. FÉDÉRATION INTERNATIONALE DES BOURSES DE VALEURS (FIBV) ............................................................ 80
1.2. WHY DON’T EXCHANGE PLACES SIMPLY MERGE ..................................................................................... 81
2. WHY MIGHT COMPANIES WANT TO LIST SHARES ABROAD? ................................................................... 82
2.1. HOW IT WORKS? ............................................................................................................................. 82
2.2. POSSIBLE GAINS FROM FOREIGN OR CROSS LISTING ................................................................................ 83
2.3. POSSIBLE COST FROM FOREIGN OR CROSS LISTING ................................................................................. 84
3. SHAREHOLDERS LIKELY REACTION TO DIVERSIFICATION OPPORTUNITIES................................................... 84
3.1. WHY WOULD NEW INVESTORS BE INTERESTED IN INTERNATIONAL DIVERSIFICATION? ................................... 84
3.2. WHY WOULD COMPANIES PREFER GLOBAL INVESTORS? A PARTIAL EQUILIBRIUM EXPLORATION ..................... 86
3.3. CONVENTIONAL WISDOM ................................................................................................................. 87
4. IMPACT ON CROSS LISTING ON FIRM VALUE ....................................................................................... 88
4.1. THE IMPACT ON THE COST OF DEPTH ................................................................................................... 90
4.2. CROSS-LISTING WAVES ..................................................................................................................... 90
4.3. THREE THEORIES TO EXPLAIN THE WEALTH EFFECT ................................................................................. 92
5. CONCLUSION ............................................................................................................................. 94
2
,PART III - INTERNATIONAL CORPORATE FINANCE .......................................................................... 95
1. MERGERS AND ACQUISITIONS ........................................................................................................ 95
2. M&AS IN WAVES - NEOCLASSIC VS. MARKETING-TIMING EXPLANATIONS ............................................... 98
2.1. THE NEO-CLASSICAL EXPLANATION FOR M&AS ACTIVITY ........................................................................ 99
2.2. IS THERE ANY EVIDENCE AS TO THE BEHAVIORAL THEORY OF M&AS ....................................................... 102
2.3. HORSE RACE BETWEEN THE NEOCLASSICAL AND THE BEHAVIORAL VIEWS ................................................. 105
3. MANAGERS’ OVERCONFIDENCE - M&A VALUATION EFFECTS AND HUBRIS ............................................. 107
3.1. LONG-TERM PERFORMANCE ............................................................................................................ 108
3.2. SHORT TERM STOCK RETURNS - A PREDICTOR OF FUTURE PERFORMANCES ............................................... 109
3.3. PREDICTIVE ABILITY OF SHORT-TERM RETURNS .................................................................................... 110
4. BEHAVIORAL BIASES .................................................................................................................. 110
4.1. MANAGERIAL OVERCONFIDENCE ...................................................................................................... 110
4.2. HUBRIS ........................................................................................................................................ 113
PART V - INTERNATIONAL STOCK MARKET ANOMALY: POST-EARNINGS ANNOUNCEMENT DRIFT 116
1. DEFINITION AND EMPIRICAL EVIDENCE ........................................................................................... 118
1.1. DEFINITION .................................................................................................................................. 118
1.2. EMPIRICAL EVIDENCE ..................................................................................................................... 119
1.2.1. First evidence of the PEAD – Ball and Brown (1968) ............................................................. 119
1.2.2. Other evidence: Foster, Olsen and Shevlin (1984)................................................................. 121
1.2.3. More evidence ....................................................................................................................... 122
1.3. LONGEVITY OF THE DRIFT ................................................................................................................ 124
2. EXPLAINING THE DRIFT - CASE OF FIRM SIZE..................................................................................... 125
3. EXPLAINING THE DRIFT - CASE OF CAPM MISSPECIFICATION ............................................................... 125
3.1. BETA SHIFT ................................................................................................................................... 125
3.2. APT (ARBITRAGE PRICING THEORY) .................................................................................................. 127
3.3. TRADING STRATEGY ....................................................................................................................... 127
4. EXPLAINING THE DRIFT - DELAYED PRICE RESPONSE .......................................................................... 128
4.1. TRANSACTION COST ....................................................................................................................... 128
4.2. TRADING STRATEGY BASED ON PRIOR QUARTERS’ SUE ......................................................................... 129
5. EXPLAINING THE DRIFT - INSTITUTIONAL AND NAIVE INVESTORS’ BEHAVIOR ........................................... 130
5.1. INSTITUTIONAL INVESTORS .............................................................................................................. 130
5.2. INDIVIDUAL NAIVE INVESTORS .......................................................................................................... 131
6. TRADING STRATEGY................................................................................................................... 132
6.1. ARX MODEL ................................................................................................................................. 133
6.2. IN-SAMPLE ESTIMATES & OUT-OF-SAMPLE PREDICTION PERFORMANCE ................................................... 133
6.3. PORTFOLIO CONSTRUCTION AND TRANSACTION COSTS ......................................................................... 134
3
,PART VI – EARNINGS MANAGEMENT AS A PERVASIVE STRATEGIC TOOL ..................................... 136
1. IMPORTANCE TO INCREASE EARNINGS ........................................................................................... 136
2. WHETHER ............................................................................................................................... 136
3. HOW ..................................................................................................................................... 139
3.1. PLAYING WITH ACCRUALS ................................................................................................................ 139
3.2. REAL EARNINGS MANAGEMENT ........................................................................................................ 141
4. WHY...................................................................................................................................... 141
4.1. PROSPECT THEORY ......................................................................................................................... 142
4.2. TRANSACTION COST THEORY ............................................................................................................ 144
4.3. OPPORTUNISTIC BEHAVIOR.............................................................................................................. 148
4.4. MAKING THE CEO LOOK GOOD ........................................................................................................ 148
4.5. INVESTORS’ REACTION TO EARNINGS ANNOUNCEMENT ........................................................................ 149
5. SEO, IPOS AND M&AS ............................................................................................................. 152
5.1. INITIAL PUBLIC OFFERING ................................................................................................................ 152
5.2. M&A’S ....................................................................................................................................... 157
5.3. STOCK REPURCHASES ..................................................................................................................... 157
PART VII – BEYOND THE RANDOM WALK..................................................................................... 158
1. INTRODUCTION ........................................................................................................................ 158
1.1. QUALITATIVE INFORMATION ............................................................................................................ 158
1.2. IMPACT ON STOCK PRICES AND CORPORATE GOVERNANCE .................................................................... 158
1.3. STOCK MARKET EFFICIENCY.............................................................................................................. 160
2. IMPACT OF SENTIMENT ON STOCK FUNDAMENTAL VALUE ................................................................... 161
2.1. NEW PESSIMISM AND STOCK FUNDAMENTAL VALUE ............................................................................ 161
2.2. TONE AND FUTURE EARNINGS .......................................................................................................... 165
2.3. SOCIAL MEDIA AND COST OF CAPITAL ................................................................................................ 165
3. HOW TO MEASURE SENTIMENT? .................................................................................................. 166
3.1. NEW AGGREGATES OF WORDS ......................................................................................................... 166
3.2. CODING ....................................................................................................................................... 168
4. IS TONE SUBJECT TO MANIPULATION?............................................................................................ 168
PART VIII – CONTENT TO BE KNOWN ........................................................................................... 170
4
, Part 0 - Introduction and motivation
- “What is the truest definition of globalization? Princess Diana’s death.”
o “An English princess with an Egyptian boyfriend crash in a French tunnel,
driving a German car with a Dutch engine, driven by a Belgian who was drunk
on Scottish whisky, followed closely by Italian Paparazzi, on Japanese
motorcycles; treated by an American doctor, using Brazilian medicines.”
o World is more and more globalized
§ When we look at covid, the stop of production in China had an impact
on the production in Belgium
§ This changed the symbolism of the borders
§ World is becoming increasingly globalized
• Globalization = increasing connectivity and integration of
countries and corporations and the people within them in
terms of their economic, political, and social activities.
• The international scope of business creates new opportunities
for firms
- If the text is put in cursive, these are slides which were not covered in the courses
1. International finance or the existence of borders
- Borders still matter in finance
o Typical economic models: closed economy (no interrelationships with the rest
of the world)
o But we live and do business in a world with distinct countries more or less
independent
o Closed economy ↔ Global integrated entity
- The growth of international trade
o 1960: only about 20% of countries were open to trade (U.S. – U.K. – Western
Europe)
o The world was dominated by the western culture = 10% of the world’s
population having access to 80% of the resources, while the rest of the world
was underdeveloped
o Early 1980s: belief in free markets leads to worldwide deregulation
o 1990: fall of the Iron Curtain + trade liberalizations
§ The world becomes open. By 2000 more than 70% of countries are
open to trade
à Result: growing trade flows between countries
- Globalization of financial markets
o Financial openness: in the 1980s many developed countries began liberalizing
their capital markets
§ Countries allow foreigners to invest in their capital markets and allow
their citizens to invest abroad
o Advantages for MNC’s:
§ Access to foreign capital
§ Ability to reduce financing costs
5
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